Saturday, December 30, 2006

Australia's nuclear future: Howard shifts ground.

As recently as last month the Prime Minister has said he would do nothing to hurt Australia's coal industry. Not any more.

It looks as if we are going to trade carbon and go nuclear.

Story and analysis below:

Prime Minister John Howard, until now a staunch supporter of the coal industry, has spoken of the need for Australia to cut its reliance on the present generation of coal-fired power stations as it moves to a nuclear future.

Claiming that nuclear power stations were safer than coal-fired stations the Prime Minister said yesterday that he would have no objection to having one built next to his own home in Sydney.

Asked whether he was serious, Mr Howard replied: "I am serious, quite serious. I wouldn't have any objection. None whatsoever."

Launching the final report of the Switkowski inquiry into nuclear energy Mr Howard said that Australians "clearly need to recognise that we can't go on using coal with the current level of greenhouse gas emissions and also make a contribution to climate change"...

As recently as last month the Prime Minister spoke of wanting to shield Australia's coal industry from the consequences of action to fight global warming saying it was "in Australia's national interest to play a part in reducing greenhouse-gas emissions, but in a way that doesn't damage our vital industries such as the coal industry".

The new stance came as the Prime Minister undertook to refer the Switkowski Report's findings on greenhouse gas emissions and the costs of different forms of power to his Emissions Trading Taskforce which is due to report in May 2007.

It heightens the likelihood that the Prime Minister will mid-next year endorse some form of emissions trading regime that imposes a financial penalty on the operators of Australia's existing coal-fired power stations in order to assist the development of new low-emission technologies including nuclear power.

Mr Howard warned that the changes would mean higher power prices. "If there are to be reductions in greenhouse gas emissions, power bills will over time go up. There's not much doubt about that, that's been said before and it ought to be acknowledged," he said.

He has asked his Industry Minister Ian Macfarlane to bring a submission to Cabinet early in the new year on ways in which the Government can quickly remove impediments to the development of nuclear power.

The Switkowski report foresees the development of 25 nuclear reactors along Australia's coast producing about one third of the nation's power when nuclear generation becomes cost competitive.

Mr Howard said that the government itself would not be building any of the reactors and it would not be choosing the sites. "I think they should be where it makes commercial sense, where environmentally it's reasonable and all the other factors that will be taken into account. But we won't be building nuclear power stations and none are going to be built in the immediate future," he said.

The Opposition Leader Mr Rudd said that the Prime Minister's stance would present voters with a clear choice at next year's election. "Either they can vote for Mr. Howard, and get 25 nuclear reactors in the country; or they can vote for us, and we'll not be having one bar of nuclear reactors for this country," he said.

Mr Howard also yesterday called on Australia's Labor state and territory leaders to remove any remaining restrictions on the mining and export of uranium. Those restrictions remain part of Labor's national policy platform.


Standby for Australia’s first nuclear power plant. The foundation stone will most likely be laid in about ten years from now.

But the final report of the Switkowski inquiry released yesterday makes clear that for that to happen a number of supports have to be put in place.

First there needs to be a single national regulator for the nuclear industry, of the kind the High Court’s recent WorkChoices decision has made possible. It would help if there was bipartisan agreement about the rules for establishing plants that would give would-be generators the confidence to invest.

Then the cost disadvantage of nuclear power needs to vanish, or a mechanism needs to be put in place where the investors would have confidence that the disadvantage would vanish by the time they are ready to produce power. An emissions-trading scheme that penalised heavy emitters of carbon such as coal-fired power stations would do the trick.

It would not need to be a particularly onerous emissions trading scheme. Switkowski finds that even with Australia’s access to very cheap coal, nuclear power would be just 20 to 50 per cent more expensive.

By contrast a coal-fired station that captured and stored carbon to eliminate emissions would be around 150 per cent more expensive.

If a system of tradable carbon permits is introduced, even at a low price, it is likely to make nuclear power a more attractive option for replacing Australia’s existing carbon-belching power stations than new coal-fired stations with built-in carbon capture.

(It would also make high-capacity wind generation attractive. Its costs are in the same range as those of nuclear power.)

It is possible for the Prime Minister’s Emissions Trading Task Force to design a permit trading system that increases the costs of coal-fired generation slowly and predictably giving would-be nuclear generators (and renewables generators) the kind of certainty that they would need to make the heavy investments necessary to replace Australia’s coal-fired plants when their working lives expire.

That Task Force reports in May. It will lay out the road map to Australia’s nuclear future.

Friday, December 29, 2006

Investing for Mobility: Fred Argy

FRED ARGY has advised governments from Menzies to Keating and has been awarded an OBE and made a member of the Order of Australia for services to economic planning. He has written widely, his latest being Australia Institute Discussion Paper no 85, Equality of Opportunity in Australia released in April 2006.

In this version of the article published in Thursday's Canberra Times he outlines the opportunity that Kevin Rudd has to promote true equality of opportunity in the coming election campaign.

* Read Nicholas Gruen and Don Arthur's reviews of Fred Argy's paper here.

Within days of becoming Opposition Leader Kevin Rudd drew a sharp distinction between two kinds of equality. Equality of opportunity was something he said he supported. Equality of outcomes was something he did not.

He is on the right track.

Australians like the idea of equality of opportunity because it taps into two of our most strongly beliefs – a system of rewards which is based on merit; and an equal chance to succeed.

They see no real point in equality of outcomes per se. We have enjoyed extraordinary prosperity, especially in recent years with the boom in export prices, so even the poorest Australians are better off than they used to be. And, while the gains in earnings have been skewed towards the top end, our progressive tax and social security system has done an excellent job of redistributing market income gains to the poorest 20% of households.

Another reason that we have no great enthusiasm for equality of outcomes is that we believe we have equality of opportunity.

We are very wrong...

Explaining why we don’t have true equality of opportunity and how to fix it is one of Kevin Rudd’s great electoral opportunities.

But first, let's define equality of opportunity, hereafter called EOP.

The narrow “classical liberal” view is that EOP merely means that each of us should be rewarded according to what we are able to bring to the labour market at any point in time. To achieve this the main thing the government needs to do is get out of the way.

The broader view of EOP is that each of us should be offered the opportunity to achieve our full potential over our lifetimes, irrespective of our social background. In order to achieve this the government has to minimise the risk factors and handicaps that hold us back early in life and ensure that there is access to education and other services that will allow us to achieve our full potential in later years.

Opinion polls suggest that this second broader notion of EOP is the one with the most support in mainstream Australia. It is also the one most likely to bind Australia together and it also the best idea economically, as it allows the full potential of the economy to be realised.

The best way to find out whether we are achieving broad EOP is through longitudinal studies that follow the same group of individuals over a long period of time. These can provide a useful measure of the relative “income mobility” in different countries – in particular the ease with which people of poor background are able to break out into higher income, occupational and social hierarchies.

What these studies show us is that neither of the two most talked about means of achieving equality of opportunity will do the job.

Freeing up markets facilitates upward income mobility but does not maximise it. It creates “more room at the top” but by itself does not ensure that everyone has the same access to the better jobs.

Income redistribution of the ‘passive’ (unconditional) kind cannot fill the gap because it does nothing by itself to develop human capabilities or to correct the underlying structural inequalities that distort the distribution of market incomes.

So what should we do? The studies suggest that the countries with the highest levels of income mobility have liberal economies mixed with high levels of social investment - in child development, public education, health care, housing, transport infrastructure, employment programs, – all targeted at the disadvantaged. The USA is not one of these countries. It has the freest and most productive economy in the world but because of its relatively low rates of social investment, fares badly on income mobility compared to, say, the Nordic countries.

How is Australia faring? In the past few decades we have both liberalised our economy, opening up new opportunities for enterprising people, and also invested heavily in our people, helping to broaden access to these opportunities. We have done well, ahead of countries such as the US and UK, although not as well as many of the smaller European and Scandinavian countries.

However, we now seem to be making the same mistake as the Americans – relying too heavily on economic freedom and not enough on active social investment to equalise opportunities.

Looking back at the main achievements of the Howard Government, most of them are economic. One could point to family benefits and lower unemployment as big social advances. And they are. But family benefits, however desirable, do nothing directly to increase human capability. And the Government’s success on unemployment conceals many worrying inequalities of opportunity in the labour market. As well, while national spending on health and education has increased, it has become less well targeted at the less privileged. The share of government benefits in kind going to the poorest households has been falling.

In my recent discussion paper for the Australia Institute, I highlighted a number of barriers to income mobility in Australia. They start in early childhood. These are perpetuated in adulthood and compounded by a range of barriers to employment, health, education, adult training, low-cost housing and public transport.

Most unskilled workers are trapped in chronic under-employment, relative low-pay, insecurity and unpredictable hours. We have large and growing education inequalities – in pre-schooling, secondary schooling and tertiary education. The technological divide is wide. And the availability and quality of health services is becoming increasingly dependent on one’s income and location.

The present distribution of market incomes in Australia might be merit-based at a point in time - but over people’s lifetimes it is at least as much a product of unequal opportunities as of relative merit. Many Australians are “stuck in the basement” not through lack of ability, effort or motivation but because but because they have no easy means of escape from the circumstances of their birth and the inequality of access to key services.

I fear that Howard’s recent WorkChoices and welfare access reforms will further compound the problem. They may help accelerate the transfer from welfare to work but they will lead to wider earnings differentials while at work and diminish workers’ voice in the workplace: More importantly, the reforms are very short-term oriented. They seek to achieve the desired employment outcomes almost exclusively by reducing the cost of labour to employers and applying the ‘stick’ to welfare recipients - instead of trying to overcome the low productivity and participation that results from poor education, inadequate training, geographical immobility and low work incentives. Moreover, the Howard reforms attack the symptoms of joblessness after they have occurred – when people turn up at the factory gate so to speak – and ignore the root causes which go back to the early childhood and teenage environment. They are “quick fix” policies without regard for the long term consequences.

By focusing on mobility and the means by which to achieve it Kevin Rudd can draw a real distinction between himself and John Howard.

The Howard way to high employment and productivity is not the only way. An alternative strategy would need to retain most elements of the liberal economy which Australia has built up over the last thirty years. For example, welfare support for able-bodied people should remain conditional on active searching for work or training. There should still be plenty of structural wage flexibility, so that wages can remain sensitive to shifts in relative productivity and structural change. And mangers should retain a considerable degree of managerial autonomy in hiring and firing (to allow firms to respond quickly and effectively to changes in market conditions).

But the alternative strategy should leave more room for collective bargaining, restore some worker-protection regulation and take a less harsh approach to access to welfare. And, most importantly, it should have as a cornerstone government investment to further activate labour participation.

The government should fund measures to correct early childhood disadvantages; remedial programs for older school children and youth who are under-performing; improved access to employment-enhancing services such as health, public education and public transport in low-income areas; retraining and life long learning programs; work wage bonuses such as tax credits for low-paid workers; assistance with entrepreneurial start-ups and targeted job-creation incentives; relocation subsidies to reduce the geographical mismatch between job vacancies and job seekers; and family-friendly policies such as flexible working patterns, paid parental leave, good quality and affordable child care assistance and family-friendly workplaces.

Mobility would be the watchword.

Would such a program be economically responsible?

It would have to be implemented gradually, with due regard for macroeconomic conditions. Over time, increasing mobility pays for itself by increasing the productive capacity of the economy. OECD studies make that clear.

In the interim, it could be paid for by broadening the tax base, eating into bracket creep or borrowing. Some of the cost could be recouped from the beneficiaries themselves through income-contingent loans like HECS.

An equal opportunity program would both appeal to Australian values and build the Australian economy.

And it isn’t being offered to the extent it should by the Howard Government.

Australia’s commodity price boom has generated 40 to 50 billion dollars of extra revenue for the Commonwealth over the last four to five years. Some of it went into the Future Fund but most of it was used to fund middle-class welfare and tax cuts.

The golden opportunity was missed.

Kevin Rudd has the chance to grab it.


Wednesday, December 27, 2006

Tuesday column: Births, conceptions and deaths. Money changes everything.

If you’ve got a birthday around now, my commiserations.

If you haven’t, you probably know someone who has and you are familiar with their pitiful refrain: people born late in December miss out on presents and recognition - their birthday celebrations get caught up in Christmas.

Think how much worse it would be if you lived in the United States.

According to the New York Times most years nowadays the biggest single day for birthdays lies between Christmas Day and New Years Day.

It didn’t used to be the case. Until around 15 years ago the busiest days for American births were always in September, nine months after the cold winter...

Around 15 years ago two things changed. One is that it became easier for parents and their doctors to manipulate the date on which their child was born. Births can now easily be brought forward with drugs or brought on early with caesareans.

The other was a steady escalation in the size of US federal government tax breaks to families that had a child. A quirk in the design of the US system means that parents can claim a full year’s tax break (worth more than $1,000) even if their child is alive for just one day or one minute of that calendar year. As a result a baby born before 11.59pm on December 31 is always worth $1,000 more than a baby born a few minutes or days later.

It is hard to imagine that anyone would deliberately bring forward the birth of their baby, possibly endangering its health, in order to earn an $1,000.

Certainly our own Treasurer Peter Costello laughed at the suggestion that such of thing would happen here as a result of the introduction of his baby bonus.

And yet according to Assistant Professor Amitabh Chandra of Harvard University each year some 5,000 American babies are born in the last week of December that would normally have been born in the first week of January.

This doesn’t mean that every parent who has a baby in the last week of December chooses that week for the money. 70,000 babies are born each week at around that time of year.

But it does mean that money has a subtle often-unseen effect on the most private of our decisions.

Many years ago Paul Hogan was hailed as the saviour of Australian tourism for his “throw another saviour on the Barbie” TV ads. And it is true that the number of visitors from North America did jump dramatically at that time. But Geoff Carmody of Access Economics took me aside and showed me a graph tracking Australia’s tourist numbers against the value of the Australian dollar. I was astounded to see how closely the two moved in tandem. When the Aussie rose, tourist numbers dropped, when it dived, as it did at about the time the Hogan ads were said to be working, the number of US tourists soared.

This doesn’t mean that each extra American tourist who came here consciously decided to do so because they knew it would be cheaper. Many would have thought they were influenced by the ads, and would certainly have been more likely to say so.

But somewhere inside some of them money was making the difference.

Australian mothers seem just as receptive to money as do mothers in the US.

As it happens Australia leads the world in researching the effect of money on the timing of births, conceptions and deaths. Economists Andrew Leigh from the ANU and Joshua Gans from the University of Melbourne have been on the Treasurer’s case for some time now.

When Peter Costello joked on budget night in May 2004 “you should have, if you can, one for your husband, one for your wife and one for the country” he would not have imagined that the $3,000 Baby Bonus he was introducing would be so effective. It was due to come into effect ten weeks later, on July 1 2004.

July 1 turned out not only to be the biggest day for births that year, but also the biggest day for births in any of the previous three decades. The second–biggest day for births in those three decades was July 2, 2004.

Day-by-day birth numbers give a good indication. On Wednesday June 30, a total of 490 births were recorded. On the next day, the first day of the baby bonus, the number of recorded births jumped to 978.

Dr Leigh believes that in total some 1,000 births were moved from one financial year to the next.

He says where this involved the falsification of hospital records it would have done no harm. Where a baby was induced to come a day or two earlier it probably would have done little harm. But he says at least 170 mothers appeared to moved their birth dates by more than seven days, potentially exposing themselves and their children to considerable risk.

It’s not only mothers who move births. Doctors Leigh and Gans examined what happened to births during obstetricians and gynecologists’ conferences. They found that in Australia and the US the number of births fell by 4 per cent and 2 per cent during the days the conferences took place.

Biology appears to be more malleable than many of us think.

I doubt whether Peter Costello really expected a jump in the birth rate when he made that joke about having one for the country. He generally sold the policy in terms of rewarding parents rather than creating them. After all, who would have an extra child in order to earn an extra $3,000?

And yet, in the winter months immediately following the Treasurer’s announcement more Australians conceived than at any time in the previous ten years.

They didn’t create their children in order to earn $3,000 (now $4,000 and set to rise to $5,000 in 2008). That isn’t how financial incentives work. What did happen was that enough people who were considering having children anyway took the extra money into account just enough to make their calculation different enough to push them over the line.

It can happen when we die as well. In mid 1979 Australia abolished federal death duties.

Doctors Gans and Leigh have found that about 50 Australians appeared to will themselves to live just a few weeks longer at around that time in order to take advantage of the change.

As a proportion of the small number of Australians who faced death duties it is a very large effect. Gans and Leigh find that over half of the Australians who were due to pay the death duty in its final week of operation managed to escape it.

Money effects the most intimate of our decisions far more than we realise. I am told it even helps some people decide whom they will marry. But most of the time we don’t admit it, even to ourselves. It is only when economists look at graphs or dig through statistics that they can see decisions being swayed. And even then, it is always someone else who is turned by the money, never you or me.

UPDATE: Joshua Gans and Andrew Leigh write about their work here.


Tuesday, December 26, 2006

Guest columnist: The Chief Minister

The ACT Chief Minister Jon Stanhope has taken issue with last Tuesday's column: Poor Little Rich State.

The Canbera Times printed his response today:

Peter Martin (op-ed, December 19) asks if he is “missing something” in relation to the ACT’s fiscal situation.

Well, yes. Starting with an understanding of Commonwealth-State fiscal arrangements, ACT finances and the ACT economy.

Mr Martin queries why, since Canberrans earn proportionately more than other Australians, their Government cannot afford to run buses more than once an hour in the middle of the day, or keep schools open...

Ignoring for a moment the fact that the most recent ACT Budget committed more funding to schooling than at any time in the history of self-government — including a massive capital injection for new schools — Mr Martin ought to be aware that there is no automatic correlation between the prosperity of a particular population and the fiscal situation of the government that serves that population.

It is true that people who earn higher incomes pay higher taxes, but in Australia this revenue flows overwhelmingly to the Commonwealth Government — not to the ACT Government — in the form of income tax, GST and excises. State and municipal taxes and charges are only weakly linked to community prosperity.

Taxes collected by the Commonwealth are not distributed dollar-for-dollar back to the communities that generated them. Rather, taxation revenue is distributed to the States and Territories according to a principle of horizontal fiscal equalisation, which ensures that those jurisdictions that have, for example, higher needs — the Northern territory, with its sparsely distributed population and special circumstances comes to mind — receive proportionately more back from the kitty than they can contribute.

Thus, there is no logic in the proposition that a community of high income-earners ought to be able to run off-peak buses more frequently than once an hour, or that such a community ought to be able to keep open schools when the system as a whole is operating at two-thirds capacity.

Is Mr Martin seriously suggesting that the Government ought to maintain 18,000 empty desks in our schools, just because our average incomes are higher than the Australian average and we pay higher income taxes to the Commonwealth? On what educational grounds? On what fiscal grounds? On what grounds full-stop?

Mr Martin comments that the ACT spent “only” $27 million more per year than the national benchmark on schools in 2004-05. He evidently regards this as an insignificant amount, but to put it in context, that’s 10% of the education budget — or more than a quarter of the policing budget. It doesn’t take too many lots of “only” $27 million to add up to a real strain on a small jurisdiction’s Budget. Indeed, our historical tendency to overlook or dismiss such “onlies” has meant that since self-government, across the board, the ACT’s expenditure on services has cost 20% more than national benchmarks.

Mr Martin claims that Grants Commission figures show that, on the whole, the ACT has overspent “only” in the areas that it has had to. Another “only”. And a list of “onlies” that, as Budget Paper 5 for 2006-07 shows, includes everything from preventative health and family and child services to superannuation, public services, pre-schools, tourism, public safety, housing and vocational training.

Mr Martin criticises the ACT for offering (until the recent reforms) its employees a ‘gold standard’ superannuation, but fails to acknowledge that this was an inheritance from the Commonwealth, bequeathed at the time of the creation of the ACT Public Service and the transfer of Commonwealth public servants to the territory service.

Mr Martin also seems to confuse taxation effort with taxation revenue. The ACT has had a taxation effort of around the national average, as assessed by the Commonwealth Grants Commission. However, the Commission also assessed that in 2004-05 the ACT’s capacity to raise tax revenue was $163 per capita lower than the national average. And when you look at overall revenue the gap is even larger - $307.

Perhaps instead of searching in vain for a non-existent nexus between private wealth and so-called public parsimony next time he waits for an ACTION bus — joining the other 2300 passengers an hour who will catch a service that has the capacity to carry 5000 passengers an hour, even after the recent network changes — Mr Martin could read up on Commonwealth-State fiscal relations. The answers to the questions he poses are not actually hard to find.

Jon Stanhope is the ACT's Chief Minister.

Tax breaks to top $50 billion!

Government spending on tax breaks is set to soar above $50 billion for the first time, largely as a result of decisions contained in last May's budget.

New projections prepared by the Treasury show that show that Commonwealth Government spending on tax concessions will climb by 25 per cent over the next three years, reaching $52 billion in 2009-10.

By then, the Australian Government will give away one dollar in tax concessions for every five dollars that it actually collects.

Much of the projected increase in concessions is accounted for by the new treatment of superannuation announced in the May budget and due to take effect next year.

From July all super payouts taken by all Australians aged over 59 will be tax-free, regardless of size, and regardless of whether the money is taken out as a lump sum or a pension. The Treasury says that by 2009-10 the change will cost it $3 billion a year.

But it is hardly the biggest of the tax breaks available for superannuation.....

The biggest are those that tax contributions to funds
and the earnings of funds at only 15 per cent instead of the
taxpayer's marginal rate.

The Treasury says in total the tax breaks for super will climb to $23
billion by 2009-10, a sum that roughly equates to one dollar for every
ten dollars of tax actually collected.

The Treasury produces its so-called Tax Expenditures Statement each
December in order to keep track of government handouts that would
otherwise be invisible because they were in the form of adjustments to
tax rates.

In the Statement the Treasury says that whereas direct government
spending is subject to continuing scrutiny by the Parliament and the
media, tax concessions are often only scrutinised once - at the time
they are introduced. They are also "generally not as obvious" because
they are delivered in the form of an adjustment to rates rather than a
payment from the government.

This year's Statement was released quietly late last week after the
Treasurer's much better-publicised Mid-Year Economic and Fiscal
Review. In it the Treasury identifies more than 100 legislated tax
expenditures, the biggest apart from superannuation being the 50 per
cent exemption from capital gains tax available to anyone who has held
an asset for a year.

By 2009-10 the capital gains tax discount is expected to cost $5.3 billion.

The Treasury says other quantified exemptions from Capital Gains Tax
total $615 million. And it says the revenue lost from 11 of the
Capital Gains Tax concessions is too hard to quantify, among them the
exemption for gains made selling the family home.

Other large tax expenditures identified in the Statement include the
Senior Australians' Tax Offset ($2 billion by 2009-10), exempting
Family Tax Benefits from income tax ($2.7 billion), exempting the 30
per cent private health insurance refund from income tax ($1 billion)
and allowing tax deductions for donations to charities ($890 million).


John Howard may or may not be the biggest spending Prime Minister in
Australian history, but he is certainly Australia's biggest user of
"tax expenditures". Tax expenditures are defined by the Treasury as
spending in disguise, dressed up as tax concessions.

Both spending and tax expenditure has the same effect. It takes money
from people such as you and me and gives it to a group the government
wants to assist.

Carers Benefits are an example of spending. They are paid to people
the government wants to assist out of money collected from you and me.

But they could operate differently, less openly. Instead of being
paid by cheque carers could be given a tax rebate, worth the same

The effect would be the same. Carers would be assisted at government
expense. There would be less money available for government spending
on other things.

But as a rebate the payment wouldn't show up in the accounts as
spending. It could be forgotten about, especially at razor gang time.
And it would seem less like welfare. As a "tax cut" it could even be
said to be cutting the size of government.

Direct government spending often goes to people in need. Tax
expenditures by contrast often go to Australia's most well off. The
biggest beneficiaries of the $17 billion offered in tax concessions
for superannuation this year will be those high income Australians who
have put the most super aside. The biggest beneficiaries of the $5
billion tax concession for capital gains will be those Australians who
have set aside the money to make capital gains.

The Tax Expenditures Statement released every year a few days before
Boxing Day is an attempt to make these invisible payments visible.

It is just a pity that the Statement itself is buried in the avalanche
of last minute reports and shopping that precedes Christmas Day.

It could be because the Government is embarrassed by the Statement.
It shows that Tax Expenditures have become the government's instrument
of choice for helping some of the Australians least deserving of help.

Back eleven years ago at the end of the Keating era tax expenditures
totaled $18 billion.

One dollar of tax was given away for every seven actually raised.

Under the Howard Government tax expenditures are on track to hit $52
billion, one dollar for every five that the rest of us actually pay.

Wednesday, December 20, 2006

How much longer can we keep handing farmers money?

Unless you are a farmer, the budget cupboard is bare.

That was the Treasurer’s message delivered to the nation and to his colleagues yesterday along with the mid-year economic and fiscal review.

That review forecasts of a budget surplus this and next financial year of a round 11 billion dollars – one per cent of GDP.

Asked how much of it could be carved off for election promises next year Peter Costello implied that the answer was none: “We have got a surplus of one percent, I think it is prudent to have surplus budgeting.”

Unless you dig into that surplus to hand money to farmers suffering from the drought.

After the latest extra drought relief measures the Government is set to spend $2 billion a year on drought assistance - $38 million each week...

Roughly half of Australian farming land in now drought-declared.

If our climate returns to what it used to be that spending should shrivel to zero.

But if Australia’s climate continues to change for the worse, either Mr Costello or one of his successors is going to have to make a tough decision.

Just as there will be no point in expecting Pacific Islanders to continue to live on islands that have become submerged as a result of climate change, there will be no point in continuing to pay Australian farmers to work land that can no longer be worked.

Drought support payments are meant to assist people facing exceptional circumstances.

The Treasurer yesterday gave no sign that he had even thought about biting the bullet. He said he would stand by people who loved the land, and if the drought got worse, he would spend more in what will be an election year. $7 million of the extra drought assistance spending has been set aside to advertise the extra spending.

Australia's mid-year budget review

The drought is set to knock more than 20 per cent off Australian farm output cutting Australia’s forecast rate of economic growth by about one third.

Unveiling his half-yearly update on the Budget forecasts yesterday the Treasurer Peter Costello conceded that his department got it wrong in forecasting the effect of the drought back in May.

At the time the Department said it expected farm output to climb by 2 per cent in the year ahead. The revised forecast is for farm output to slide 21 per cent...

Largely as a result Australia’s overall total rate of economic growth this financial year is expected to slip from the 3.75 per cent forecast at budget time to 2.5 per cent.

And the Treasurer concedes there could be worse to come. His current forecast assumes that it will rain next year. If it does not, Australia’s rate of economic growth will fall further.

Asked why his Department had assumed that it would start to rain in the midst of Australia’s worst drought for sixty years, he replied that was standard forecasting procedure.

“We always forecast normal conditions. What else can we do? Unless somebody can tell me what the rainfall is going to be next year, all I can do is assume it will be normal. Now, we look at the last one hundred years and we say rain will be normal next year. I hope it is, but what can I do?” he said.

The Treasurer said that there was a greater risk that his forecasts would have to be revised down than up.

But he said that even with the forecast cut in Australia’s rate of economic growth the economy was still traveling well.

“You’ve got to remember that it is slowing off an incredible base. In Australia, I think we have been creating 1000 jobs a day. Now that is the kind of job creation that we have never seen in our country before. Suppose it came down to 800 jobs a day or 700 jobs a day. Nobody is going to say it is zero jobs a day. And it certainly won’t be negative jobs a day.”

Mr Costello expects Australia’s inflation rate, currently 3.9 per cent, to begin falling and to keep falling until it returns to the Reserve Bank’s target band of 2 to 3 per cent. “We would expect that in this current quarter fuel prices would actually detract from the consumer price index and we think that fruit and vegetables might actually detract from the index. We are expecting the profile of the CPI to come down to the middle of the band by 2008.”

The budget surplus forecast is little changed at 11.8 billion dollars, up one billion. The government has spent less than projected on benefits such as the Newstart unemployment payment and the Disability Support Pension, in part because of Australia’s healthy jobs market, and in part because of the tougher work tests that came into force this year, the Treasurer said. Offsetting those savings had been extra spending on measures including defence and drought support.

Asked whether drought support would continue even if the drought did not end and farms became no longer viable Mr Costello said that it would and that it would quite possibility increase if the drought did not end: “The Australian Government will stand by Australia’s farmers in a severe drought, in many respects as bad as we’ve had for a hundred years. We will stand by our farmers because they are people who work hard, they are people who love the land and they are people who are going through a tough time. And if that takes further drought assistance, we’ll do it,” he said.

“Our economy is being buffeted by drought but nobody is being buffeted to the extent of our farmers. One of the reasons why you run a strong economy is so you can help farmers in their time of need. We have increased drought assistance by over $1 billion. If the drought persists next year, drought assistance will increase as well, but we will see Australia’s farmers through.”

The Treasurer suggested that he would resist calls for further tax or spending promises leading up to next year’s election saying that at 1 per cent of GDP Australia’s projected surplus was about right. “It has taken us ten years to get to where we are now, we have got to keep our Budget in surplus. I consider a reasonable surplus to be 1 per cent of GDP,” he said.

Monday, December 18, 2006

Tuesday column: Poor little rich state

Am I missing something? The ACT is richer than it has ever been. An average worker here takes home $1,056 per week. In NSW it’s $870. In the past year take-home pay here jumped 8.5 per cent (mainly because more of us are working full-time) In NSW it scarcely moved.

Spending here climbed 4.2 per cent in the last year. In NSW it increased scarcely at all.

And unemployment here is so low that it’s now difficult to measure. The best guess is that only 5,600 of us are looking for work.

So why is it that we apparently can’t afford to keep our schools open and can’t afford to have ACTION busses running more frequently than once every hour in the middle of the day?...

It can’t be because we don’t want these things. All the evidence suggests that a society’s income increases it starts demanding better schools, better hospitals and – yes – better bus services.

And it shouldn’t be because we can’t afford these things. If, at a time when the ACT economy is about as good as it could ever get we can only afford one bus an hour, what will we be able to afford when things turn down?

I am told that the answers to these questions lie in a secret report prepared for the ACT government by the head of Actew Michael Costello and a former head revenue in the Commonwealth Treasury Greg Smith.

The review itself wasn’t secret. The Chief Minister announced it with something of a fanfare a year ago. He said it would put everything “under the microscope”.

Perhaps he didn’t like what it found. The report has been under lock and key ever since Jon Stanhope took delivery of it.

It is hard to imagine why he wouldn’t want us to know the truth about what we can afford as uncovered by the two people in the best position to know.

Perhaps it is because it would tell us some things that Jon Stanhope doesn’t want us to know.

A look at the latest Grants Commission report comparing spending and taxing across the states and territories provides some hints as to what that might be.

Someone much better than me at pulling out figures from such reports has used a pen and paper to work out where the ACT “over spends” compared to the rest of Australia and where it “under taxes”.

The first surprise is that, on these figures the ACT hardly overspends on schools at all.

The ACT spent $315 million on schools in 2004-05. That’s only $27 million more than it would have spent had it spent at the same rate as the nation as a whole.

But the ACT did overspend on pre-schools. Its expenditure of $13 million was almost twice the national rate.

And its spending on universities was almost 10 times the national rate.

(By the way I am not arguing that the ACT should cut its spending on universities or pre-schools to Australia-wide rates. As I have pointed out we are generally richer than the rest of Australia and the richer a society gets the more it demands spending on services such as education.)

In dollar terms the ACT’s overspending on education is tiny compared to the two areas in which the ACT administration does overspend big time.

One is superannuation payments for its public servants. The ACT spent almost $400 million on superannuation benefits in 2004-05, more than it spent on schools, pre-schools and universities combined. It spent almost two and a half times what it should have, based on state and territory norms.

Why has the ACT been so much more generous than any other state or territory?

Because, unlike every other state and territory, it has had to in order to attract workers. Right next door to the ACT administration and much bigger is the Commonwealth public service. It treats its employees to the gold standards in superannuation schemes – the CSS and the PSS. Until now the ACT has done so as well in order to keep pace. It pulled out of the race in July this year. From now on new ACT public servants will join a much less generous scheme, but it will take decades for the higher spending to fade.

And the ACT overspends on health and welfare compared with the rest of the nation. It spends 40 per cent more than the Australian norm - twice what it does on schools. It does it in large measure because it has to pay more to attract and keep doctors. As anyone new to Canberra who has tried to find a general practitioner will know, there aren’t that many doctors here. They seem to prefer living by the coast.

Most doctors know very little about the ACT. Until two years ago we didn’t have a full-service medical school. The ANU took in its first undergraduate medical students only in 2004. They will graduate at the end of next year, and perhaps they will want to stay in Canberra. But until the numbers build up we are going to have to pay over the odds for doctors.

The Grants Commission figures show that on the whole the ACT has overspent only in the areas that it has had to. And it has under taxed... not at all. According to the figures I have seen the ACT earned about the same from taxes and charges in 2004-05 as would have any administration.

The ACT is not unusual in feeling the need to cut services at a time when its population is at its richest. When the NSW was at its economic peak its teachers had to bring in their own chalk.

There is probably a broader explanation for the present paradox of private wealth and public parsimony. It’s something I’ll ponder the next time I am unwise enough to wait for an ACTION bus.

Peter Martin is economics editor.

Friday, December 15, 2006

Saturday Forum:The impressive Warwick McKibbin

Time is important to Warwick McKibbin. Arguably Australia’s busiest, quite possibly Australia’s most brilliant, technical economist he measures it in slivers. It is also at the core of his world-renowned economic model.

When I tried to find just half an hour to see him at his office in the ANU I was told he busy at meetings of the Switkowski inquiry into nuclear energy, then he was off to Sydney for a day-long meeting of the Reserve Bank Board (the one that pushed up interest rates) then off to speak at the Lowy Institute to speak about climate change.

At other times he is briefing John Howard’s Cabinet (twice a year as a member of the Prime Minister’s Science Engineering and Innovation council - “I keep throwing my pet topics on the table and the Cabinet engages”) or in Washington where he is also a Senior Fellow at the Brookings Institution, or at home in Deakin where he runs a business selling software for his computer model of the economy to international clients including central banks, funds managers and global corporations...

He has sold more than 150,000 copies of his software worldwide. His clients like it because it is better at predicting how an economy will react to shocks than its more expensive competitors. It takes into account the value of time. McKibbin likes to joke that he is only small businessman on the Reserve Bank Board.

When I do meet him in his office at the ANU’s Coombs Building there is no time to waste. We sit down at a side table and he explains with passion how almost everyone on both sides of the climate change debate is wrong.

It takes me back to when we first met, in Tokyo when I was working as the ABC’s correspondent. Warwick McKibbin phoned, said he was visiting and suggested that we have a bite to eat. Back then experts were either supporters or opponents of the Kyoto Protocol. I don’t remember the detail what he said over soba noodles but I do remember the way in which he said it.

It was obvious that both sides were wrong. Globally agreed targets to cut carbon emissions would never work, and nor should they. Why adopt a target when no-one knew what it was necessary to achieve? What you needed was a mechanism that would set up a framework for action and get people on board. He had come with a framework that would work and in time people would see that his was the right one.

I asked him where I could find out more. He spelled out his web address:

Warwick McKibbin is used to being right when almost everyone else around him is wrong.

At the age of 17 he joined the Reserve Bank in Sydney as an office assistant.

“My job was emptying the punch card machines. It was great because if you dropped them and had static electricity and a synthetic carpet it took about a day to pick them up.
It was really funny,” he remembers. “I did that during the day and I went to university at night.”

After six months the Reserve Bank decided that he might make a good computer programmer and enrolled him in a training course in the Bank.

Later it awarded him a scholarship to study economics fulltime, in Australia and at Harvard where he obtained his PhD.

He returned to the bank in 1987 because he had made a commitment but had “not a very pleasant time”. At that time when everyone in authority in Australia from the Treasurer Paul Keating down believed that the way to fight Australia’s growing current account deficit was to push up interest rates. Warwick McKibbin insisted that they were wrong.

“I even published a paper saying so and I was told if I published it I would probably never get promoted. So I published it any way.” He left after three years.

McKibbin’s view is now universally accepted as correct.

When the Berlin Wall fell in the late 1980’s it was generally believed it would turn Germany into an economic powerhouse. McKibbin’s model said it would instead be the start of Germany’s decline. So far he has been right. During the Asian economic crisis of the late 1990’s it was widely feared that Australia would fall into recession. McKibbin said the crisis would on balance be good for Australia. He was right again.

But what about the US-Australia Free Trade Agreement I ask him: “You put your name to modeling commissioned by the Department of Foreign Affairs and Trade that said it would be an economic bonanza for Australia. Three years on we are hardly selling any more to the US than we used to.”

He replies: “Actually our argument wasn’t that the trade flows would change very much, but that capital flows would change. There would be a lot more US investment in Australia than before.”

I think of this week’s $11.1 billion takeover bid for Qantas, the multi-billion dollar equity fund deals involving Channel Seven and Nine.

“Well not in that form, but that’s exactly what we were talking about. We didn’t think it would be equity capital but in fact we predicted that there would be quite a big change in the country risk premium because people in the US would be more confident in Australia,” he says, adding in a moment of rare modesty: “I am a bit reluctant, but I think that’s right, I can claim that one I suppose.”

McKibbin says he was selected personally by the Prime Minister to serve on the Switkowski Review into Nuclear Energy. “He wanted serious people on this review and I am probably the only person in Australia who has done serious work on this.”

The review was widely expected to find that there was an economic case for uranium enrichment, for the storage of foreign nuclear waste in Australia and for a domestic nuclear power industry without the need for a carbon tax. It found none of those things.

McKibbin says he is pretty sure that John Howard was surprised: “…but then I usually don’t toe any line, I just speak what I believe.”

He believes that it is the Switkowski inquiry that has led to the current remarkable inquiry into carbon emissions trading, an idea the Prime Minister once said he never would countenance.

McKibbin asked not be a member of the Prime Minister’s emissions trading task force. He wants to present his ideas to it. They are ideas that should strike a chord with the Prime Minister.

McKibbin says the Kyoto Protocol cannot and will not work. For one thing it requires international governments to trust each other to do the right thing. And even if they did the flows of capital across borders as emission permits were traded would massively distort exchange rates.

And there’s something else. Treaties lock governments into targets that they lack the political ability to meet. “In a democracy, a policy doesn’t become credible simply by being written into law. Every subsequent government will have the ability to repeal the law or to relax enforcement until it is irrelevant. Why would an energy company want to make a long-term investment knowing that? It’d easier to lobby to neuter the law.”

McKibbin says what is needed is a scheme that will create a constituency with a strong financial interest in keeping the climate change policy on track: “Bluntly, you’ve got to create a powerful lobby group that will vigorously resist backsliding.”

Here’s how it work for Australia. Carbon emissions would be illegal without a permit. But the government would issue lots of them, enough to cover somewhat less than Australia is emitting now. The permits would allow the emission of one tonne of carbon each year for the next 100 years. (“About the lifespan of a Canberra lease,” he says).

The government would hand them out for free. But – it would hand out only half of them to carbon emitters. The rest it would give as a gift to each Australian household – probably two permits per household, worth about $1000 each. Polluters will need them and they will try to buy them from households.

“But $1,000 doesn’t sound like much money”, I suggest. What sort of incentive is that going to give households?

“If you hold on to it, it would be like being given Microsoft shares. Eventually as the price of carbon emissions climbs those permits would be worth an enormous amount of money,” McKibbin says.

Households will find it worthwhile to lease their permits out to business rater than sell them. Each year the government will set a new price of carbon (“in the same way as the Reserve Bank sets interest rates”) and if that price is higher the value of the permits will increase. A constituency will be created that wants the government to increase the price of carbon every year.

If the government ever tried to walk away form the scheme or water down its enforcement, it would have a mutiny on its hands. Householders, businesses and superannuation funds would be ropeable at the prospect of seeing the value of their investments plunge to zero.

No-one could ever corner the market in permits because the government would always supply on demand a permit for one year’s worth of emissions at the price it had set. Businesses would always be able to pollute if they really wanted to, at a price that ordinary citizens would be pushing to have increased.

Because the government could vary the “spot price” for each year’s emissions of carbon as it wished, it wouldn’t be locked into anything. If the evidence about climate change became more compelling, it could push up the price. If it became less so it could push the price down.

When other countries saw that the system worked they might adopt it too. But they wouldn’t have to. And Australia’s participation in the scheme wouldn’t depend on other countries.

The McKibbin scheme is carbon trading without a carbon target and without Kyoto, the sort of thing likely to appeal to Australia’s Prime Minister. As might the notion of a nation of carbon-permit capitalists. John Howard has talked often of his pride in helping create the world’s biggest share-owning democracy. McKibbin’s idea might help him go further.

But what if Australia isn’t ready for it? McKibbin says he is used to that. He will be proved right in time. But quite possibly not in this country. He says the US is interested in his scheme. He resigned from his position at the ANU this week but is still in discussions with them about his future. “I am not sure how it will turn out. After February, I might become the Reserve Bank's first unemployed Board member, which would be funny.'”

But he thinks things will turn out alright. It's another Warwick McKibbin forecast that might be proved right.

Ian Macfarlane's worried, Glenn Stevens is worried...

The former head of the Reserve Bank says “major financial instability” is likely to hit Australia within the next two decades and he believes we lack the tools to deal with it.

In the sixth and final of his Boyer Lectures to be broadcast on the ABC on Sunday Ian Macfarlane says he believes that Australia faces a threat “greater than the threat of inflation, deflation, the balance of payments and the other familiar economic variables that we have confronted in the past”...

The former Governor says he is concerned about the effect of performance-based pay on fund managers who are under increasing pressure to lift returns. “There is an incentive for them to take on more risk, particularly to hold assets that offer a high expected return in order to compensate holders for the possibility that, in rare circumstances, there will be a huge loss. It can have the effect of encouraging managers to chase short-term profits, even if long-term risks are being incurred, because if the risks eventuate, they will show up on someone else’s shift,” he said.

Mr Macfarlane’s comments amplify those made by his successor as Reserve Bank Governor Glenn Stevens who on Tuesday expressed concern about the growth of leveraged buyouts funded by private equity firms of the type that have bid for Qantas and Coles Myer.

Until this year leveraged buyouts in Australia in Australia averaged only $1.5 billion each year. This year up until Thursday the total was an unprecedented $13 billion. The Qantas deal, announced on Thursday, adds another $11 billion to that total.

Dr Stevens said that leveraged buyouts by private equity funds were essentially bets by that share prices would remain strong and that the cost of funding their debts would stay low.

The funds typically borrow heavily to buy and privatise large public companies, refloating them on the stock exchange five to ten years later at what they hope will be a profit.

Mr Macfarlane said the Australian public was more exposed to the fallout from any collapse in financial markets than ever before. Household debt was at an all time high. Many people had “taken on higher levels of debt than they desire, because they felt it was the only path to home ownership, given the strong rise in house prices over the past decade.” And more than half of adult Australians now owned shares directly, and many more through superannuation funds.

The former Governor said that the growth of superannuation and with it a shift to share market-based accumulation funds had increased the exposure to risk.

Whereas once employers had shouldered financial risks for their workers by offering defined-benefit payouts now most super payouts depended on the earnings performance of a particular fund. “In other words, it depends on what happens to share prices, bond yields, property prices and so on,” Mr Macfarlane said.

“I do not wish to criticise the current arrangements for retirement incomes in Australia because over time they will allow most people to retire on higher incomes than formerly. The only point I wish to make is that for a large part of the population, their standard of living in retirement will depend to a significant extent on how the value of financial assets perform, and hence they are more exposed to financial risk than under earlier arrangements.”

Mr Macfarlane said that the increased exposure to financial markets and the increased tolerance of risk in those markets was likely to make the economic effect of future booms and busts bigger.

He said he expected such a challenge within next two decades and he doubted that the public would accept the Reserve Bank pushing up interest rates to prevent it.

“If the central bank went ahead and raised interest rates, it would be accused of risking a recession to avoid something that it was worried about, but the community was not,” he said.

The Reserve Bank had “a very limited armoury with which to fight against a potentially dangerous asset price boom”, its chief weapon being jawboning in the form of speeches, parliamentary testimony and research papers, which was “of limited effectiveness”.

“How would [the Reserve Bank] cope if it faced an asset price boom of the magnitude of those that occurred in the United States in the 1920s or Japan in the 1980s? Not very well, I expect, but it would probably be held largely responsible for the distress that accompanied the bubble’s eventual bursting,” the Mr Macfarlane said.

The lecture will be broadcast at 5.00pm Sunday on Radio National. The series will be published as a book by Allen and Unwin entitled The Search for Stability.

Thursday, December 14, 2006

Unsentimental about Qantas

Thirteen years ago Labor’s Deputy Prime Minister and Minister for Finance Kim Beazley stood in front of a Jumbo on at Sydney Airport and declared that all Australians would have a chance to share in the success of their own airline.

He launched an emotion-laden advertising campaign fronted by a raft of celebrities not normally thought of as investment advisors, among them Kate Ceberano, James Morrison, James Blundell, Hayley Lewis and Ian Kiernan.

As he put it, they were well-known Australians talking about “the chance that all Australians have to invest in Qantas, one of our great national companies”.
It made the idea of privatization not seem so bad. Qantas would still be publicly owned....

Not Now. If, as is inevitable given the offer price, enough Qantas shareholders accept the takeover offer in February Australia’s national carrier will become truly private. It won’t be possible to own any of it and it will be pretty hard to find out what it is up to. The new owners won’t need to report to the stock exchange or hardly anyone else.

If it had been known this was how things would turn out back in 1995 Kim Beazley would have found it far harder to sell the concept of Qantas going private, no matter how many celebrities he coaxed into miming “I still call Australia Home”.

He and his successors as Ministers would have found it hard to vote as they have done repeatedly to keep out competitors to Qantas on international air routes. Most recently a year ago Singapore Airlines was blocked from flying between Australian and the US in what was believed to be the national interest.

It wasn’t a decision taken in travelers’ interests; it was a decision in the interest of Qantas and its 100,000 Australian shareholders, most of them mums and dads.
Government MP Bruce Baird is a former Chief of the Australian Tourism Council and until now one of Qantas's great supporters.

He has argued strongly for foreign airlines to be kept off Qantas's routes.
Last night he put the airline on notice that he might do so no longer.
``If Qantas becomes just another company, and for instance start moving jobs offshore, all bets are off,'' he told me.

The new Qantas will find it hard to play the patriotism card. The government might start acting in the interests of travelers instead.

Our next Australian Statistician

The next head of the Australian Bureau of Statistics says he is looking forward to returning to Canberra, but that he is “only sorry there isn’t a beach just that bit closer.”

An ABS veteran, Brian Pink left to run Statistics New Zealand six years ago where he directed both the 2001 and the 2006 census.

The Treasurer Peter Costello late yesterday announced his appointment as the next Australian Statistician, succeeding Dennis Trewin who has resigned and leaves in March.

An economist, who for many years headed the Bureau’s information technology division, Brian Pink is excited about the kind of statistics the ABS will soon be able to deliver.

“More and more local communities want information about themselves, in increasing detail,” he told me on the phone from Wellington last night...

“Technology makes that possible. In both countries we are looking for opportunities to leverage off administrative systems that are created for other reasons – land titles records, council permits, - a whole range of information that before computers sat in index boxes.”

A keen sailor and surfer Brian Pink is sad to be leaving the harbour city of Wellington but he says he is looking forward to moving into the ABS’s new headquarters in Belconnen. “Just before I left the ABS in 2000 I sat on the board that helped draw up the specifications for the building,” he said. “I want to find out how it’s worked.”

Mr Pink said he regarded his new job as a privilege. “I am conscious of the fact that I will be the custodian of an institution right at the heart of what a democracy is all about. It not only keeps the heartbeat of the economy but it is part of the way in which a community judges the performance of the government,” he said.

Wednesday, December 13, 2006

The Governor is worried...

About private equity funds. I outline his concerns this morning, as detailed below the fold

Australia's Reserve Bank says it is concerned about the growth in
leveraged buyouts financed by private equity funds.

In his second speech since becoming Reserve Bank Governor Glenn
Stevens said last night that leveraged buyouts of the type arranged
for Channel Nine and proposed for and Qantas were increasing
Australia's venerability to financial stress.

He said that the Bank and Australia's big private banks recently
conducted a macroeconomic stress test in which they simulated the
effect of a very large fall in house prices, a recession, a big rise
in unemployment and a sharp depreciation.

He said there were no widespread loan defaults and the banks
themselves remained "well and truly solvent".

However he said if leveraged buyouts mainly funded by private equity
funds continued to expand the results would become "more worrying".

Until this year leveraged buyouts in Australia were worth around $1.5
billion per year. In 2006 they jumped to around $13 billion.

Mr Stevens said that number still accounted for only a small
proportion of Australian mergers and acquisitions, but there was a
feeling that the growth could continue. The buyouts were essentially
a bet that Australian share prices would remain strong and the cost of
debt would stay low.

"We may at some stage face less forgiving circumstances than we have
enjoyed over the past decade," he said. "We need to be alert to the
shift in the wind in the area of corporate leverage that seems to be
occurring. I suspect we will be talking about that for some time to

Dr Stevens told the Committee for the Economic Development of
Australia in Melbourne that he wanted to perform financial stress
tests more often.

"We have indicated to the chief executives of the participating banks
that we would look to do this type of stress test roughly once every
two years, and I look forward to their support for this," Dr Stevens

In answers to questions at the CEDA dinner Dr Stevens said that he
that the housing construction cycle may have bottomed out.
Australia's very low rental vacancy rates lent support to this view.

He that his opinion about Australia's economic outlook had not changed since the Bank's last hike in interest rates in early November.


Tuesday, December 12, 2006

Things won't be so bad...

When we are all old.

The latest NATSEM-AMP Report on spending and income in the year 2020 is actually upbeat, as I outlined for Tuesday's Canberra Times:

Retailers concerned that Christmases will become quieter as the population ages can rest easy.

A study to be issued today by the National Centre for Economic Modelling at the University of Canberra finds that by 2020 we will be spending far more than ever before, much of it on the same things.

By 2020 four out of every 10 households will be headed by a person aged over 54 years. But despite this, the typical household is expected to spend 22 per cent more each week than it does today, adjusted for inflation.

Australia's increased population is expected to push up total household spending by 50 per cent in real terms.

The Natsem Income and Wealth report prepared for the AMP finds that some expenditures will lag. Spending on baby food will increase by only 27 per cent; spending on toys by only 38 per cent.

But other spending will climb steeply.

We are likely to spend about 60 per cent more on medicines, 61 per cent more on hospital and nursing home fees, and 62 per cent more on health insurance an increase of $3.8 billion a year over what we are paying now.

We will also be gambling much more. Natsem says our spending at the TAB will triple; our spending on instant lotteries will climb 80 per cent. We will be reading more with our spending on newspapers climbing by 66 per cent, despite the internet, and we will be drinking more, with spending on alcohol climbing 54 per cent, somewhat above the 50 per cent increase in total spending.

According to Natsem's projections there is little reason to worry about our ability to afford the extra spending. Our income is expected to increase by a couple of percentage points more than our spending, implying extra saving.

Tuesday column: Could Christmas gifts be bad?

So, you’re dreading Christmas. I am too. Not the day itself, but the agonizing hunt for presents in the weeks leading up to it.

I am prepared to spend a lot – most working Australians plan to spend around $830 according to the financial group AXA – but I don’t know on what.

My fear is that unless I buy extremely well, I will spend maybe $50 on something that is worth much less than $50 to the person who receives it.

Economists have a name for this concept: a deadweight loss. Small government advocates are always evoking it...

The government collects from you say $20,000 a year, and spends it on your education, health and so on. But because the government doesn’t know what you need as well as you do, you won’t get as much value from the $20,000 as you would have had you spent it yourself.

Some estimates put the deadweight loss of taxation as high as 20 per cent. That means that for each dollar of our money the government spends for us, we only get 80c worth of value.

Over Australia's entire economy the annual lost value the deadweight loss might be $70billion.

But what about Christmas? How much value might be lost to us each Christmas because we swap inappropriate presents instead of swapping cash?

It's the sort of question only an economist would ask. Economist Joel Waldfogel, from Yale University, asked it first 13 years ago in a seminal paper entitled The Deadweight Loss of Christmas.

He asked university students to estimate both the amounts paid for the gifts they had received and the amounts that those gifts were actually worth to them. He found that at least 10 per cent of the value of the gifts was destroyed in the giving.

In a later, more sophisticated study, he put the figure at between 10 and 18 per cent of value lost as much as $9billion throughout the United States each Christmas. If you doubt Professor Waldfogel about the inefficiency of present giving, consider present recycling.

A survey conducted by American Express found that 28 per cent of us rebirth some of the presents we receive as gifts for other people. And then there are returns. The US Journal of Consumer Research has concluded that 16 per cent of all gifts bought by men are returned to shops by the recipients; 10 per cent of all gifts bought by women. (Women are better at choosing the right gifts than men).

So given the anguish gift buying causes people like me, and given that from a financial point of view the process is pretty much the same as tearing up $100 notes, why on earth do we still do it?

Two British economists Todd Kaplan and
Bradley Ruffle have set out to answer the question in a paper just published in the Journal of Economic Literature entitled: Here's something you never asked for, didn't know existed, and can't easily obtain: A search model of gift giving.

Their theory, summed up by the title, is that there are situations in which the gift giver will know more about the desires of the person receiving the gift than they do themselves. I am sure you know the feeling; it is often a wife or a husband. As well, the gift giver might have knowledge about the latest products or how to obtain things that the recipient doesn't have. I remember well the day my dad gave my aged grandfather a modern shaver for Christmas. Grandpa hadn't known that they
existed, and he didn't normally approve of Christmas, but he was thrilled.

I bought my wife an iPod (about my one success in the field of gift-giving) and she loved it because the whole idea was new she hadn't really been aware of it.

Present giving is extremely common when we come back from overseas. We've been able to obtain something exotic that the person receiving the gift couldn't get at home.

So important do Kaplan and Ruffle think this phenomenon is that they say it might just cancel out the deadweight loss identified by Waldfogel. They say that: "just maybe, on average, gift giving may make people better off than in its absence".

But other things are important as well. Many of us don't like spending on ourselves.

A few years back, Ran Kivetz and Itamar Simonson from Columbia and Stanford universities, offered 6000 Americans the chance to take part in a lottery. They were given a choice of what to accept as a prize in the unlikely event that they won either cash or a luxury prize of lesser value. One lottery offered the choice of either $55 in cash or a premium bottle of red wine (retail value $50). Another offered the choice of either $85 in cash or a one-hour facial (maximum retail value $80).

Financially there is no question as what's best the cash. You could spend the cash winnings on a bottle of wine or a facial and have money left over. And yet about a quarter of the Americans tested went for the luxury prize. Asked why, they said things like: "If I chose the cash, I would probably spend it on something I need rather than something I would really enjoy" and "This way I will have to pamper myself and not spend the money on something like groceries".

Perhaps that's why we continue to give presents notwithstanding what may be their economic inefficiency. We like to be pampered, and usually we're too stingy to do it ourselves. I know exactly the double CD I want for Christmas, and I have dropped a fairly unsubtle hint about it. Normally I'd be reluctant to spend the money, but at a time of indulgence, what the heck?

And the look of pleasure on my wife's face at the look of surprise and pleasure on mine will make it all worthwhile.

Sunday, December 10, 2006


Prime Minister, for setting up a Taskforce to investigate the concept of emissions trading!

Get those submissions in now.

My note of congratulations, in Monday's Canberra Times, is over the fold.

The Prime Minister should be congratulated, not condemned, for setting up an inquiry to emissions trading.

Within minutes of John Howard announcing the terms of reference and membership of the inquiry yesterday environmental critics labeled it a “joke”, stacked in favour of industry.

It is true that many of the members of the Prime Ministerial Task Force are from industry. Peter Coates is from Xstrata, one of Australia's biggest coal exporters, John Marlay is from Alumina Limited.

But composition doesn’t guarantee outcome. Just ask business figures Peter Hendy and Dick Warburton. In the lead up to this year’s budget they were bleating about how Australia’s tax rates were too high.

The Treasurer asked them to inquire into how Australia's tax system compared internationally, they were forced to conclude that it fared well, and they stopped bleating.

The fact is that a system of emissions trading has a lot to offer business when it comes to cutting greenhouse gas emissions. It ensures that they are cut in a way that produces the least economic damage.

An inquiry with broad terms of reference, as this one has, is likely to find that out.

One of its members is the Secretary to the Treasury Ken Henry. Nobody’s stooge, he has one of the finest minds in the land when it comes to understanding the power of market mechanisms, and how to harness them in the national interest.

It won’t be easy to design an emissions trading system that really works well. Many people say that the European system does not and that the Kyoto system cannot without the participation of big polluters such as China and India.

The Taskforce has been given five months to distil what is known and come up with the best possible scheme that serves Australia’s interests.

It is a big gesture for a Prime Minister who has previously opposed emissions trading to set up such an inquiry.

There is no way he can possibly know what it will recommend.

If its recommendations are well argued they are likely to greatly assist Australia to navigate the challenges posed by Kyoto without too much economic damage.


Thursday, December 07, 2006

Workchoices may well have created more jobs


That's what you would expect in the good times.

The question is... what will happen in the bad times.

That was the point of my analysis piece after Thursday's employment figures.

The Treasurer's claims (as quoted by me) are below it.

Analysis CT Friday December 7, 2006

The Treasurer says that WorkChoices deserves a lot of the credit, and he is probably right.

Employers have taken on almost 200,000 extra Australians in the seven months since WorkChoices came into force, almost all of them in full-time jobs.

As Mr Costello put it in a Parliament House courtyard yesterday: “I think something structural may well have gone on in the labour market. It appears that employers are now more confident of hiring people, and they have gone out and they have done it.”

It was an outcome never in serious doubt.

All of the literature about employment protection laws says that when those laws are weakened employers will be more confident about hiring people. If they know they can easily sack them later there is little reason to hold back.

In an economic upturn weakening employment protection laws will encourage employers to take on even more workers. It’ll be good for jobs.

But that’s not all the literature says.

In an economic downturn weaker employment protection laws will make it easier for employers to cull their workforce. Weak employment protection laws will encourage employers to sack even more workers. It’ll be bad for jobs.

These two forces are not in dispute. What is in dispute is which one will predominate over time - whether, averaging out the good times and the bad, we would have more people in employment with or without a regime such as WorkChoices.

We won’t know that until there is a downturn.

The jury is still out.

What Peter Costello said CT Friday December 7, 2006

The Treasurer has declared WorkChoices a success in the wake of a yet another surprise jump in the number of Australians in work.

An extra 36,200 Australians found jobs in November, more than reversing a contraction in October and taking the total number of Australians in work to yet another all-time high.

Since the introduction of WorkChoices in March an extra 197,300 jobs have been created, almost all of them full-time.

Peter Costello said yesterday that while he was not claiming that WorkChoices itself had created those jobs he could say that those who had warned that WorkChoices would destroy jobs had been proven wrong.

“I doubt that we have seen a year like this - a quarter of a million new jobs in the space of one year. Remember the ACTU audience at the Melbourne Cricket Ground last week where they got 40,000? I want you to think of six times that crowd, because that is the number of people that got jobs this year. Six times the crowd the ACTU pulled out to the MCG. And since the introduction of WorkChoices, five times the crowd got new jobs that they pulled out to the MCG.”

Australia’s national rate of unemployment remained steady at 4.6 per cent in November. It has been below 5 per cent since WorkChoices become law.

Until recently 5 per cent had been thought of as full employment. The Treasurer said yesterday that in light of the latest inroads into unemployment it might be time to redefine full employment.

“We have gone below what used to be considered full employment. Now, we don’t actually know what full employment is now because we are outside the range but seeing as the economy is still producing jobs at the rate that it is, we should try and get unemployment lower. Here is what we should try and do – have a job for everyone who wants one and it is clear there are still some people who are looking for work who don’t have jobs, and we should try and create opportunities for them,” he said.

Mr Costello agreed that the news on jobs was inconsistent with weak news on economic growth released on Wednesday. “Employment is a lagging indicator but you normally wouldn’t see such robust increase in an economy which is slowing. Now, it is an interesting point as to how and why this is happening. It may well be that people are more confident about putting on employees in the aftermath of WorkChoices,” he said.

Unemployment in the ACT remained broadly steady at 2.9 percent, the lowest rate of any state or territory.


Wednesday, December 06, 2006

Want to export wheat your own way? Just try.

That's how it has been until now.

In this morning's Canberra Times I outline the bizzare Catch 22 that awaited would-be exporters, "the best catch there is":

ANALYSIS: Level playing fields with catch in the rye

Until now anyone has had the right to apply to compete with the AWB in selling exporting wheat. Australia’s Wheat Export Authority considered applications on their merits.

But there was a catch, imposed by legislation. Joseph Heller would have called it “Catch 22”.

The Wheat Export Authority was only able to approve applications if they had been approved by the AWB itself.

And the AWB’s criteria for deciding whether or not to let in a competitor?

Well, it had nothing to do with whether or not that competitor had the financial capacity for the job or whether or it would be able to get wheat growers higher prices.

CBH is Western Australia’s third-largest exporter selling around three million tonnes of grain each year. At the moment it is only able to export grains such as barley and canola because the AWB won’t let it export wheat.

Last month it applied for the right to export two million tonnes of Western Australian wheat to Indonesia, Malaysia and Vietnam, at what it guaranteed would be higher prices than the AWB had been offering.

And the AWB’s Response, delivered last month, as it was awaiting what turned out to be damning findings from the Cole Royal Commission?

It said “no” because in its words, approving the application “would not be consistent with the intentions of the Wheat Marketing Act”.

Why not?

Apparently the intention of the Act “is not to create competition with the National Pool that would undermine National Pool returns.”

Indeed, given the AWB’s status as a private company, the directors would have probably been failing in their fiduciary duty to shareholders if they had allowed in a competitor.

That’s why the Prime Minister yesterday stepped in to remove the AWB’s power to veto wheat exports by competitors, and that’s why, despite the bluster of AWB supporters such as Senator Barnaby Joyce, he is most unlikely to ever give it back.

Farmers get new avenue for wheat

Australian farmers will soon be free to export wheat through an organisation other than the AWB.

Prime Minister John Howard announced plans yesterday to remove the AWB's power to veto the export licence applications of its competitors. Instead, for an interim period of six months, that power will be given to Australia's Agriculture Minister Peter McGauran, who will exercise it in consultation with other senior ministers “in the national interest”.

By contrast, the AWB's legislation has essentially required it to exercise its veto power in its own interest. Last month the AWB rejected an export-licence application by the West Australian grower-owned trader CBH, saying that it was obliged to protect the interests of the growers that sold through it. CBH said last night it would resubmit its application to Mr McGauran as soon as the legislation passed.

The compromise legislation was approved by a meeting of Coalition MPs yesterday morning and will be rushed through Parliament before it rises for the year tomorrow.

It is needed to end what is effectively a grains strike by Western Australian growers, 70 to 80 per cent of whom are withholding this year's crop from the AWB, some of them storing it in CBH-funded warehouses, until CBH is granted an export licence.

The circuit-breaker mirrors one proposed last week by Senator Andrew Murray, of the Australian Democrats, who moved in the Senate that the AWB's veto power be transferred to the Treasurer. Mr Howard said yesterday that he had seen Senator's Murray's proposal and that “if there is any coincidence, well there is nothing wrong with that”.

He said he had decided to move the export power to Mr McGauran rather than to the Wheat Export Authority in the wake of the Cole royal commission, because “the Wheat Export Authority itself was, how shall I put it, the subject of comment by Cole”.

Over the next three months the Government will consult widely about whether there is any need to continue with a single-selling desk backed up by an export veto.

“People can now have a proper debate about the merits of a single desk. I mean there are single desks and single desks and it depends who operates it. Some people argue, I am not saying this is my view, but I am injecting this into the debate, some people argue you can have a single desk operated by an entirely different company which is owned by the growers. Others argue you need a situation where an enhanced or changed Wheat Export Authority licenses a number of exporters; others argue for full deregulation, others have got other proposals,” Mr Howard said.

West Australian Liberal MP Wilson Tuckey who had been preparing a private member's Bill to end the single desk, said he was happy with the Prime Minister's interim arrangement.

National Party Senator Barnaby Joyce, who is a strong supporter of the single desk, said he was “far happier with the minister having control than what the alternative was, which was that we lose the single desk complete deregulation”.

He signaled that the fight wasn't over, saying that over the coming months growers had to “absolutely bang their pots and get on their tractors and tell the whole world, especially those living in Canberra, that they do not want to lose the single desk”.

Monday, December 04, 2006

Tuesday Column: Rudd's promises

In the end it was Beazley 39, Rudd 49.

Surprisingly, Rudd actually made a few promises in his first day on the job.

I analyse them below in Tuesday's canberra Times column.

As Kevin Rudd himself put it within minutes of assuming the leadership: “Now the new and the real work begins”.

It’ll be more difficult for Labor than ever before.

I’ll explain.

In the past it was possible to win an election by promising to spend money. Both sides of politics did it. In the 2004 election Mark Latham and Julia Gillard promised Medicare Gold. On the other side of politics John Howard and Peter Costello promised a tax rebate on childcare. Each produced figuring showing that even after the extra spending the budget would still be in surplus, and their promises were considered paid for.

Not any more.

Last month the Reserve Bank redefined “paid for”. In its Quarterly Economic Statement it declared that the Australian economy was operating "with very limited spare capacity”.

Stripped of bankers language that means that any extra government spending that encourages us to spend will push up inflation and force the Bank to put up interest rates.

That will be so even if the extra spending leaves a budget surplus intact.

It is a constraint that did not exist in earlier elections. In many of them unemployment was high and business could have done with a boost that wouldn’t have pushed up inflation. Even during the last election Australia’s rate of unemployment was 5.5 per cent.

At 4.6 per cent (and possibly even less when the next figures are released on Thursday) Australia’s current rate of unemployment is so low that it is not possible to argue that anything that adds to spending won’t push up inflation and then interest rates.

Especially given the Reserve Bank’s four increases in interest rates since in a row since the last election.

For an election promise to be salable this time around it’ll have to be seen not to add to public spending.

Which rules out most promised to spend money.

(There are some exceptions, such as the Coalition’s promise to end the tax on superannuation payouts, but most of these sort of ideas have already been taken.)

So what will Labor’s two new leaders promise at the next election if they can’t promise to spend more money?

In part they will promise ideas and values, taking their cue from Mark Latham, the last Labor leader to face an election. Three years ago on taking the Opposition Leader’s job he talked about reading to children.

Kevin Rudd did much the same thing yesterday. He spoke about the family: “the most important thing of my life, the backbone of my life”. And then about federation. There is overlap and uncertainty about which government does what in Australia, and it doesn’t require money to fix up. This is a costless promsie, the kind that Kevin Rudd needs.

Undoing much of WorkChoices won’t cost money either. Nor will action on climate change. If it involves a carbon tax, it might even make the government money.

But several of Kevin Rudd’s policy priorities outlined yesterday will cost money, big-time. And it is hard to know how he will be able to turn them into workable policies in the changed political-economic environment.

His promises to improve access to education and health would be very expensive if made concrete. Yesterday the new leader harked back to the days when he said he was able to take advantage of the free university education made possible by Gough Whitlam. It is an implicit promise that would cost billions to put in place.

I can almost hear Peter Costello’s line of attack. Battlers will be asked to pay higher mortgage rates in order to allow privileged children such as Kevin Rudd to go to university without charge. (And despite his parent’s status as share-farmers Kevin Rudd was privileged. He was bright enough to go to university.)

It will cost money also cost money to save manufacturing, something about which Kevin Rudd was passionate yesterday. He talked of the need for the government to be engaged, to “not sit idly by”.

As he put it: “I am actually a long-term believer in industry policy. That may be heretical, but I come from a long background in the state public service, and I know what it takes to get key industrial projects going. Let me tell you it doesn’t happen just by going and standing over there with your arms folded waiting for some magic to occur. Government has to have its sleeves rolled up and that goes for getting underway major infrastructure and industrial projects across the country.”

Mr Rudd appears to be talking about tax breaks or targetted government spending.

If he is, and we will know soon because he has promised “defined, concrete policy”, it is easy to argue that it’ll push up interest rates.

The Treasury Secretary Ken Henry has laid out the path of attack. In a speech delivered just last month he said: “Almost every day I hear somebody arguing that some activity should be accorded a special taxpayer-funded hand-out, either because it will ‘create’ some impressive number of new jobs or because, if it doesn’t receive taxpayer-funded support, an equally impressive number of jobs will be ‘destroyed’. These arguments must be based on a view that the economy is in a state of chronic under-utilisation of labour and that the central task of government is to provide taxpayer-funded subsidies to those who have sufficient wit to find ways of employing people”.

“That view is at odds with what we observe in the Australian economy of today, where policy settings have achieved a period of sustained success and, as a consequence, labour is in scarce supply. It is because of the intensity of competition for scarce labour that we hear so much about ‘skill shortages’ these days.”

The Treasury chief was sounding a warning to both the Government and the Opposition. The rules will be different in the next election. Sending more money will only push up interest rates. You’ll have to promise something else.